Trade Trumped: A War on the Horizon?

Last week at the Davos conference, Trump’s Commerce Secretary Wilbur Ross stated: “Trade wars are fought every single day… So a trade war has been in place for quite a little while, the difference is the U.S. troops are now coming to the rampart.” These are very aggressive words coming out of the US administration.

We’ve heard it before, but this time it’s different

During the first year of this administration, we have become quite used to hearing statements that amount to nothing more than chest pounding, whether in the formal press, or via social media outlets such as Twitter. What’s different this time is that the words were followed up by action, as the US imposed tariffs of 30% on imported solar panels and washing machines. This is the first unilateral trade restriction imposed by the administration as part of a broader protectionist agenda. More threats on trade restrictions have been uttered since, with the US now talking about curbing American purchases of foreign steel and aluminum, citing threats to national security as the reason for doing so.

During an interview with the UK’s ITV television station, President Trump stated that he’s “had a lot of problems with the European Union”, adding that “they’re not the only ones”, implying that his trade restrictions will be far reaching. He stated that the EU’s trade policy with the US will be “much to the detriment’ of the EU.

What makes this very interesting to the global markets, is that while the US is busy threatening trade restrictions on Europe and ‘others’, threatening to tear up existing trade pacts, such as NAFTA, and putting up walls around its borders (literally and figuratively), the rest of the world is working to facilitate and expand the flow of goods and services across borders.

The EU in the past year has negotiated the CETA free trade agreement with Canada, as well as the EU-Japan Economic Partnership Agreement. They are also in negotiations to expand upon their existing free trade with Mexico, and working on a free trade pact with a number of countries in Latin America.

The Trans-Pacific Partnership, which the US withdrew from, has now been signed by Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore and Vietnam.

Be Safe

As we are risk managers first and foremost, we seek to understand what might happen to the FX markets should a full-blown trade war break out, and how to best deal with the fall out. It’s difficult to predict what would happen to currencies in the event of a trade war, as it depends on the breadth of countries involved. Historically, during periods of uncertainty, the market experiences a period of a flight to safety, and we see gold, the US dollar and other safe haven currencies like Swiss Francs rally. But what happens when it’s the US who is at the ’ramparts’ in the center of the trade war? Last week at the Davos conference we heard Secretary Mnuchin verbally intervene in markets, to talk down the USD. If the US really is going to start a trade war, expect much more of this type of rhetoric.

So what does one do to protect themselves from adverse FX impacts on their performance? Hedge. During periods of growing uncertainty, it is best to take risk off the table, and watch as the events unfold from a position of safety.

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